Mortgage borrowing strategy

Monday 26 October, 2009

The OCR will be increased in the next year, which is leaving borrowers uneasy. However, given the positive and steep slope of the yield curve, we see little value in any fixed rates beyond one year. While borrowers need to be prepared for higher rates, structural changes mean the OCR will not push up anywhere like what we have seen in previous cycles.

Our view

The market is now expecting the RBNZ to start hiking rates in early 2010. Almost 130 basis points of hikes have been priced into the first six months of 2010, and the forward curve implies the OCR will end up over 6 percent over the second half of 2011.

Key driving factors include an interest rate hike from the RBA, a better tone to domestic data, and a worrying read on Q3 inflation. On top of this the market is also mindful of history, which has shown the RBNZ to push rates far higher than initially expected. And while history may not repeat, people certainly expect it to rhyme.

Borrowers need not panic. Certainly the window for getting attractive long-term rates has closed, with even the 2 year rate now above 7 percent. But there are other dynamics to be wary of. The economy continues to face challenges. The unemployment rate is still rising. The NZD/USD has passed 0.75 and looks likely to keep pushing higher. We struggle to see the RBNZ hiking in that environment. In addition, people are overlooking the role of fiscal policy. Facing years of large structural deficits, fiscal consolidation means a more contractionary stance for fiscal policy, allowing monetary policy to remain supportive for longer. While there is some debate over when the RBNZ will start to hike rates (we think later as opposed to earlier), we do not believe the NZ economy can sustain the extent of rate rises the market is banking on.

Borrowers need to factor in structural changes to the yield curve. We continue to harp on about this but it is something borrowers need to be aware of. New liquidity rules mean the mortgage curve will remain positive and steep. So if you want certainty, there will be a price to pay. Borrowers are naturally shortening their duration. This carries risks of course, as eventually rates will move up. People will naturally squeal when this occurs. But they are overlooking the big picture. Because so many people will be on short-term rates, the RBNZ will achieve considerable policy traction, which will mean rates should not need to have to rise anywhere near as far as in previous cycles. On top of this we believe the neutral OCR is lower than previously calculated (owing to lending margins being wider given where deposit rates sit). Overall, given where mortgage rates are at present, we see little value fixing beyond one year.

Source: National Bank, Property Focus